guys i need ur help

CAPITAL INVESTMENT DECISIONS: 1

Losrock Housing Association is considering the implementation of a refurbishment
programme on one of its housing estates which would reduce maintenance and
heating costs and enable a rent increase to be made.

Relevant data are as follows:

(i) Number of houses: 300.
(ii) Annual maintenance cost per house: £300. This will be reduced by 25% on
completion of the refurbishment of each house.
(iii) Annual heating cost per house: £500. This will be reduced by 30% on completion
of the refurbishment of each house.
(iv) Annual rental income per house: £2100. This will be increased by 15% on
completion of the refurbishment of each house.
(v) Two contractors A and B have each quoted a price of £2000 per house to
implement the refurbishment work.
(vi) The quoted completion profiles for each contractor are as follows:
Number of houses refurbished
Year 1 Year 2 Year 3

Contractor A 90 90 120
Contractor B 150 90 60

(vii) Contractor A requires £100 000 at the commencement of the work and the balance
of the contract price in proportion to the number of houses completed in
each of years 1 to 3. Contractor B requires £300 000 at the commencement of
the work and the balance of the contract price in proportion to the number of
houses completed in each of years 1 to 3.
(viii) An eight year period from the commencement of the work should be used as
the time horizon for the evaluation of the viability of the refurbishment programme.
Assume that all events and cash flows arise at year end points. Savings and rent
increases will commence in the year following refurbishment.
Ignore taxation.

Required:

(a) Prepare financial summaries and hence advise management whether to accept
the quote from contractor A or contractor B in each of the following situations:
(i) ignoring the discounting of cash flows; and
(ii) where the cost of capital is determined as 14% and the discount factors
given in appendix 1 are available. (14 marks)
(b) For contractor A only, calculate the maximum refurbishment price per house at
which the work would be acceptable to Losrock Housing Association on
financial grounds using discounted cash flows as the decision base, where the
initial payment remains at £100 000 and the balance is paid in proportion to the
houses completed in each of years 1 to 3. (5 marks)
(c) Suggest additional information relating to maintenance and heating costs
which might affect the acceptability of the existing quotes per house where
discounted cash flows are used as the decision base. (3 marks)
(Total 22 marks)